Stocks won’t be delivering double-digit returns for quite some time yet. Why not? Let’s do a little macro-analysis.
Imagine the S&P as one big company, and let’s examine the kind of returns those retained earnings need to generate the hoped-for double-digit gains in earnings. In this example, what we’ll call S&P Enterprises has 100 shares outstanding, and the shares sell at $100 each, for a market cap of $10,000. Earnings per share are the inverse of the current S&P PE of 17.9, or $5.6 per share, and total earnings are therefore $5600. Analysts are forecasting that in 2019, S&P Enterprises will raise EPS by 10.8%, or from $5.60 to $6.20 per share. I don’t think so.
S&P Enterprises is currently paying dividends amounting to 40% of those 2019 earnings, or $2480. That’s a decent yield of 2.5%, but that money goes straight to shareholders, and not to growth-building investments.
Buybacks help a tiny bit. S&P Enterprises devotes one-quarter of that $6200 in profits––$1550––to repurchasing its shares. Hence, the purchases will lower the share count by 1.55%, from 100 to 98.45 shares, raising existing investors’ ownership share in the business. But to reach that 10.8% return, the big workhorse has to be profits reinvested in the business. And I mean big. S&P Enterprises is plowing 35% of its earnings, or $2170, into growth projects. Even with the lower share count, to get to $6.20 in earnings-per-share, S&P Enterprises needs to generate a 23% return on reinvested earnings, raising the number from $2170 to $2670.
The point is that corporate America is depending on 35% of its profits––the dollars reinvested in plants, warehouses and the like––to generate almost all of future growth in total profits. Those kinds of gains are only possible when corporate America is roaring back from economic disaster. This does not seem possible starting from today’s already record profit gains, when labour costs and interest costs are both increasing due to record low unemployment and the inevitable Fed intervention against inflationary pressures.
Reaching double-digit returns on investment from what are already astounding levels of profitability is a fantasy, like imagining the day when a frantic flapping of your arms will help you fly.